ETF Investing Strategies

Why You Should Add ETFs to Your Portfolio

Including exchange-traded funds (ETFs) in your investing strategy might be the way to go if you're looking to diversify your portfolio, increase market exposure, or invest extra cash. 

There are several ETF investing strategies that you can take advantage of—just be sure to consider your investment goals first. Once you understand the risk you're comfortable with taking, you can incorporate ETFs into your investing strategy.

Risk Management

Portfolios that have exposure to certain market sectors can purchase or short sell an ETF in that particular sector to hedge against risk. Investors can counter risk by taking the opposite position with the correlating ETF.

Within sectors, you can choose ETFs that invest in groups of securities that have a more conservative profile if that fits your needs, such as the iShares 1-3 Year Treasury Bond ETF (SHY) to preserve value, although the rates will be correspondingly low.

International Exposure

Investors can gain exposure to international markets that show potential growth by purchasing shares in a foreign ETF that follows the index for a particular country. However, it's important to pay attention to the pros and cons of foreign ETFs. While investing in a foreign ETF is an easy way to hedge and gain country-specific exposure, you may not be able to get access to small and mid-cap companies as easily if they aren't part of a country's index ETF. 

In some cases, international exposure can be achieved by including foreign currency ETFs in a portfolio. It helps to read up on foreign ETFs to help with your investing strategy. You can investigate other, alternative types of foreign ETFs, such as those that focus on a specific market, international bond ETFs, or commodity ETFs that are tied into global markets such as coal or gold. 

Try approaching international ETF investing from different angles, such as foreign currency ETFs. For example, invest in the euro with the Invesco CurrencyShares Euro Trust ETF (FXE) or invest in Japanese yen with a fund such as the ProShares Ultra Yen ETF (YCL). You can also search for lists of foreign currency ETFs and ETNs for more ideas.

Consider investigating different market segments, too. You can also search for a list of emerging market ETFs for opportunities such as international bond ETFs like the iShares JP Morgan Emerging Markets (EM) Local Currency Bond ETF (LEMB).

If you want to hedge your portfolio with securities from a specific country, such as China, try an ETF that focuses on a specific sector of the country. Also consider China ETFs that replicate an index, or Chinese currency ETFs.

Industry Exposure

For certain industries that show potential growth or even a decline, an investor can purchase industry ETFs that follow the indexes for those particular market sectors.

This allows an investor to gain exposure to an industry as a whole without having to corner the market on all the related stocks of a sector, or at least on the major players.

You can gain exposure, for example, to the aerospace industry by investing in the iShares U.S. Aerospace & Defense ETF (ITA), or choose one of the most popular, high-volume industrial ETFs, the Industrial Select Sector SPDR Fund (XLI). This ETF covers several industries, including marine, transportation, infrastructure, aerospace, defense, road and rail, and machinery, among others.

Cash Flow Utilization

Extra money can be put to use by purchasing short-term ETFs during periods of excess cash flow so there's always an opportunity for earning a potential return. During periods of cash flow deficit, ETFs can be easily liquefied with one single trade.

Short-term ETFs are so-called because they invest in bonds with a short time to maturity. The fund manager replaces bonds as they mature to maintain the fund.

Price Differences (Arbitrage)

There can be price differences among an index and its derivative contracts, such as futures and options, due to volatile market conditions like currency and interest rates. The buy or sell of an ETF can take advantage of the arbitrage opportunity when it's calculated correctly, but it's a difficult strategy to utilize.

Management Transitions

The accountability of a portfolio will change hands when fund and portfolio managers change positions or leave financial firms. The purchase or sale of a short-term ETF can help bridge that transition period in order to compensate for any risk exposure.

Specialized Strategies

An investor can utilize various ETF trading strategies to better manage their portfolio in general or to take advantage of information from market forecasts after conducting a thorough analysis. 

If an analyst has confidence in the overall market but is bearish on a particular sector, one or a combination of specifically targeted ETFs can allow investors to take advantage of this information. 

In a long-term investing strategy scenario, an investor can buy a specific ETF to fill a gap in an otherwise well-diversified portfolio. In short-term investing situations, targeted ETFs can be used to hedge positions and may involve leverage or reverse-leverage scenarios.

For example, an investor can purchase an ETF that tracks the broad market while short-selling an ETF in the particular sector that analysts have forecast to underperform.

Targeted ETFs allow investors to get exposure to particular areas of conviction while still being able to control risk by hedging with inversely-correlated ETFs.

The Possibilities Are Abundant

With the ETF market growing so rapidly, the trading strategies at your disposal are limited only by your own ingenuity. There are even some great ways to use ETFs as part of your earnings season investment strategy.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.